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Doc. 8422
26 May 1999
EBRD and transition in central and eastern Europe
Report
Committee on Economic Affairs and Development
Rapporteur: Mr Karoly Lotz , Hungary, Liberal, Democratic and Reformers' Group
Summary
For the countries of operation of EBRD, 1998 has been a year of stress and contrasts. The turmoil in emerging markets has put the quality of reforms in transition economies to the test. The crisis has also highlighted the critical importance of the capacity of the state to enforce laws and curb corruption, collect taxes, regulate banks and financial markets, implement bankruptcies, promote enterprise restructuring and effective corporate governance, and build the social foundations for a well functioning market economy. These are also the key challenges of the next phase of the transition and they remain at the top of the agenda for all countries in the region.
In 1998 the EBRD also faced its toughest test since the foundation of the Bank. The collapse of financial markets in the Russian Federation and the continuing repercussions have increased the risks for the Bank's projects and operations considerably. At the same time, the Bank is learning lessons from the complexity and cyclical nature of the transition process. It will continue to focus on the development of the private sector, placing a stronger emphasis than before on supporting the local private sector; on providing leadership for the development of business start-ups and small and medium sized enterprises; on demonstrating effective approaches to restructuring viable enterprises; and on contributing more actively to institution-building in its countries of operation.
How governments respond to economic crisis appears to depend on the effectiveness of democratic institutions and on the commitment of political leaders. In the final analysis, there is a strong correlation between democratic political regimes and the progress in transition. Here, the Council of Europe makes a valuable contribution in various fields related to democracy, human rights and the rule of law. In the long process of transition, the complementary roles of the EBRD and the Council of Europe are evident and clear.
I. Draft resolution
1. The Assembly has taken note of the report prepared by its Committee on Economic Affairs and Development on the activities of the European Bank for Reconstruction and Development (EBRD). It commends the Bank on its strong, nearly decade-long efforts to assist the countries in transition in central and eastern Europe in the difficult overhaul of their economies and in their quest for an ever-strengthened democracy to underpin development. Such assistance continues to be of vital importance, as some of the Bank's countries of operations have suffered unexpected setbacks, while those most advanced are entering new, unknown stages of the transition process.
2. The Assembly commends the EBRD on its continued strong attachment to the promotion of democracy in all its operations. It notes the Bank's close co-operation with the Council of Europe in this regard, including its reliance on Assembly reports emanating from its Committee on the Honouring of the Obligations and Commitments by Member States of the Council of Europe (Monitoring Committee). In this context, it welcomes the prospect of an agreement between the Bank and the Council of Europe's Social Development Fund to co-ordinate activities.
3. The Assembly notes that the EBRD for the first time in 1998 registered a net loss after provisions of 261 million euros, in large measure owing to the financial and economic crisis in Russia. The Assembly welcomes the Bank's determination this notwithstanding to pursue its operations in that hard-hit country as well as in others in similar difficulties, even as it observes additional prudence in the selection of project partners. The Assembly is at the same time heartened by the steady economic progress observed in numerous other countries in transition and by their energetic pursuit of reform.
4. The Assembly welcomes the conclusion drawn by the EBRD from the difficulties it has experienced, namely that even a good project cannot succeed or bring transition forward unless it takes place within the context of a state structure with sufficient authority and within a sound institutional, macro-economic and social framework. The Bank's operations must therefore increasingly support and encourage host country policies conducive to such conditions being met. They include clear, non-discriminatory and stable business legislation; the overcoming of corruption and economic crime; the promotion of good corporate governance; enterprise restructuring; a strengthening of the fiscal system; and the building of an adequate social safety net.
5. Institutional reform is particularly important to central and east European countries seeking membership of the European Union. EBRD projects there should have as their goal to prepare for early EU membership, especially as regards the building of institutions, the raising of industrial performance and the improvement of infrastructure, notably in environment protection.
6. The Assembly welcomes the EBRD's increasing focus on promoting the start-up of new companies and the growth of small and medium-sized enterprises (SMEs) in close co-operation with local and regional partners, and by building banking sectors that display a clear commitment towards SMEs
7. The Assembly encourages the Bank to engage more strongly in the build up of an equity portfolio in companies and local banks in order to promote good corporate governance.
8. The Assembly also supports the Bank's increasing efforts to help restructure large, potentially viable enterprises. Such projects can have an important "demonstration effect" on other companies and investors, especially when coupled with projects undertaken in favour of small and medium-sized enterprises and local infrastructure development to provide new employment for those affected by restructuring. The Bank should develop a co-ordinated approach with the World Bank and other international financial institutions as well as the European Union in order to soften the social impact of the restructuring.
9. While aware of the EBRD's statutory commitment to directing 60% of its operations towards the private sector, the Assembly believes that, for these to succeed, the Bank's attention must also be given to projects to improve often obsolete and insufficient infrastructure, including in the public sector, on behalf of the environment, energy, nuclear safety, transport and communications
10. The Assembly calls on the EBRD to re-examine its so-called traditional "uniform pricing" policy, that is, the practice of applying the same loan conditions to countries with sometimes widely differing risk profiles. More differentiated loan conditions are desirable not only in the light of the increasingly heterogeneous nature of the countries of operations, but also because EBRD funding is increasingly being "crowded out" by other sources of financing in the more advanced transition countries. These countries, however, still need EBRD assistance in many fields, such as environment protection and energy efficiency, especially in preparation for EU membership.
11. The Assembly calls on the EBRD to stand ready to provide assistance in the reconstruction process in south-eastern Europe once peace has been restored.
12. The Assembly notes the great dependency of EBRD countries of operations on vigorous economic growth in the developed market economies. It therefore calls on these countries to pursue necessary structural reform in order to ensure lasting growth that can also benefit central and eastern Europe, and to refrain from any measures impeding trade with transition countries. In this respect the EBRD is to be encouraged in its efforts to stimulate trade and infrastructure investment that aids individual regions or helps them co-operate with other regions, including across national borders.
II. Explanatory memorandum by Mr Lotz
Contents
I. Introduction
II. The Bank's Political Mandate
III 1998: a "Stress Test" for the Transition Process
IV. The impact on the Russian crisis on EBRD activities and the Bank’s response
V. Concluding Remarks
I. Introduction
1. The European Bank for Reconstruction and Development (EBRD) was established in 1991. Article 1 of the founding Agreement says that its aim is to foster the transition towards open, market-oriented economies in central and eastern Europe as well as in the successor republics of the former Soviet Union. It is also to promote, through tailored investment strategies, private and entrepreneurial initiatives in countries committed to and applying fundamental principles of democracy and the market economy.
2. The EBRD has sixty members: 58 member countries and 2 institutions (the European Union and the European Investment Bank). Its main areas of action are the promotion of the private sector, the restructuring of financial institutions, the strengthening of the legal system and the development of the infrastructure necessary to support countries at different stages of their transition process.
3. At the initiative of the Committee on Economic Affairs and Development, a co-operation arrangement was concluded in September 1992 between the Parliamentary Assembly and the EBRD. The arrangement in particular foresees annual visits by the committee (together with representatives of certain other Assembly committees) to the Bank's headquarters in London for exchanges of views with the EBRD’s President and senior officials, the participation of the Bank's President in an annual debate in the Assembly on EBRD activities and the exchange of information between the Assembly and the EBRD.
4. Since the conclusion of this co-operation arrangement, the Assembly has given its steadfast support to the EBRD in its effort on behalf of transition and has, in its annual reports, provided comment and advice on its work. The Assembly’s regular monitoring has permitted all of parliamentary and political Europe to gain a better understanding not only of the Bank’s activities and evolution but also of the overall development of the region where it is active.
5. At its meeting at EBRD headquarters in London in March 1999, the Committee on Economic Affairs and Development focussed on the challenges of the new phases of transition entered into by the several countries of operations, their impact on the Bank’s activities, as well as on issues such as enterprise restructuring, nuclear safety, and the Bank’s new priorities.
6. The Rapporteur is sure he speaks on behalf of the whole Committee in expressing his warm thanks to the Bank’s new President, Mr Horst Köhler, for the warm welcome he and his colleagues extended to us on this occasion and for the very fruitful exchanges of views we were able to have with them. The Rapporteur also had the opportunity to meet with several officials of the Bank outside the Committee's official meeting. All these talks formed the basis for the present report. In addition, the Rapporteur attended, on the Assembly’s behalf, the Annual Meeting of the EBRD held in London from 19 to 20 April and reported back to the Committee on its results. Finally, the Rapporteur thanks his colleagues on the Committee on Economic Affairs and Development for their valuable contributions in London and in Strasbourg. They have also to the extent possible, been accounted for in the report.
II. The Bank’s political mandate
7. The EBRD has a unique mandate to promote the transition towards the market economy and a free and democratic society in the countries of central and eastern Europe and of the former Soviet Union. In implementing its mandate, the Bank focuses on investing in the private sector, but also increasingly realises that a functioning market economy has to be supported by an effective institutional framework. Thus, the Bank's investments have more recently also focussed on facilitating the process of economic adjustment and institution-building1 in the region, trying to make sure they have a "transition impact".
8. The circumstances surrounding the creation of the Bank - the desire of the West to assist democratisation and economic transition - help explain why it was given its particular mandate that set it aside from private banks. It also explains why its activities are based not only on commercial criteria but also on political ones. In Belarus, for instance, the Bank has limited its engagement and discontinued lending in reaction to insufficient respect for democratic principles. By contrast, in Bosnia and Herzegovina the Bank has become an important investor following the entering into force of the Dayton Agreement. It is also for political reasons that the Federal Republic of Yugoslavia has not yet become a member of the EBRD. In monitoring political developments in its countries of operation and in carrying out its political mandate, the Bank relies extensively on the judgement of relevant international institutions, prominent among them the Council of Europe.
9. Mr Köhler told the Committee at its London meeting that EBRD had made immediate use of recent Council of Europe documents on Georgia, Albania, Bulgaria and the Ukraine. No doubt the reports of the Parliamentary Assembly's Committee on the Honouring of the Obligations and Commitments by Member States of the Council of Europe (Monitoring Committee) fit hand in glove with need of the Bank's for up-to-date analysis of democratic progress. Similarly, the reports prepared as part of the Octopus programme - a joint project between the European Commission and the Council of Europe to fight corruption and organised crime in states in transition - have been useful.
10. According to an assessment given in the Bank's Transition Report of 1998, the political transition in the region has shown remarkable progress and resilience. A number of authoritarian regimes remain, however, such as in Belarus and in countries in central Asia, where true multi-party democracy has not yet taken hold. The reliance of such regimes on undue intervention and control undermines sound economic decision-making and prevents effective response to economic difficulties.
11. Economic policy-making in a number of countries, notably Russia, is further distorted by powerful interconnections between industry, finance, media and politics. These also weaken the functioning and stability of democracy. It is more than co-incidental that the quality of economic governance consistently tends to be higher where multiparty democracy is stronger. Weakness in democratic and economic governance is often associated with corruption, which in turn inhibits investment and further reform. A report adopted by the Assembly in 1998 -"The Threat to Europe from Economic Crime" (Resolution 1147; Doc 7971; Rapporteur: Mrs Helle Degn) - convincingly argued that corruption not only causes severe stress in the everyday lives of populations but also stifles economic initiatives. It destroys confidence in government and political processes and corrodes the political support that is vital if reforms are to be taken forward.
12. The Bank sees the reduction in bureaucratic controls and regulations (at least up to a certain point) as central to the fight against corruption and hence the progress of transition. For this to take place strong leadership is required, but it is all too often lacking. With a dismantling of controls and strong leadership, measures to counter corruption stand a chance of success. Without them they will fail. All international institutions can do to help combat corruption is to set standards of sound practice in their own dealings with countries of operations and to inform about ways in which it can be vanquished.
13. Fighting corruption requires action by government, business, the international community and groups within civil society. It must be high on the agenda in the next phase of the transition process. The Bank has recently stepped up its efforts to prevent crime and corruption in its own operating environment, for instance by selecting partners in the private sector that are not only credit-worthy but also meet the test of personal integrity. In the public sector, the Bank is applying procurement procedures similar to those used by the World Bank.
14. Already in 1995 the Bank adopted procedures designed to detect possible money laundering by its various partners. In the field of corporate governance, EBRD has developed a set of sound business standards and publicises them in its project management policy. In Addition, the Bank had created a set of guidelines published in September 1997 to help companies understand some of the broader concerns that lenders and investors have when considering a potential loan or investment opportunity in the region. The Bank is also currently preparing a set of guidelines reflecting the essential principles of good corporate governance.
15. As for the Bank’s political mandate, the Rapporteur considers the so-called country strategy documents prepared by the Bank to be important for a policy dialogue with host authorities. The country strategies assess the institutional and regulatory environment within which projects are developed, evaluate local legal practices, define the investment climate and progress in institution-building, and can lay the basis for the project co-operation planned. In this context, it's interesting to note that, in the different workshops and seminars of the Bank’s annual meeting in London, some participants questioned the Bank's capacity to engage governments in a deeper or broader policy dialogue. Even Mr Freeman, formerly the Bank's first Vice-President, agreed that the Bank should not stray far beyond its current role of project financing. As he put it, " the EBRD is supposed to be a player, not a referee".
16. The Rapporteur believes that the Bank should continue conducting such policy dialogues on matters related to its mandate, such as the values covered under Article 1 of its statute, the protection of the environment and nuclear safety.
III. 1998: A “Stress Test” for the Transition Process
17. For the countries of operations of the EBRD, 1998 was a year of stress and contrasts. The turmoil in emerging markets put the quality of reforms in transition economies to the test. The turbulence led to contrasting developments across the region. While some countries were, and remain, severely affected by a 'crisis of confidence' in emerging markets on the part of investors, others have shown more resilience and have been able to maintain growth, albeit at a slower rate. Although the crisis is not yet over, it is clear that countries that pushed ahead with more far-reaching structural and institutional reforms, mainly in central and eastern Europe, have passed the 'stress test' of the past year and have been able to maintain macro-economic stability (barring any future complications).
18. In a number of other countries, in particular Russia, the contagious effects of East Asia's crisis have been readily propagated in an environment where reforms had been misguided or incomplete. Poor corporate governance, slow restructuring and weak financial systems have seriously impaired the transition process, constrained growth and exacerbated instability. In many cases these defects in reform reflect weaknesses of the state itself. In Russia, for instance, the government has failed to overcome strong and manipulative vested interests, both from the old structures and the new oligarchs, in its attempt to pursue reform. Recognition of these political bottlenecks has seriously eroded the confidence of investors. The Russian experience underscores the importance of institutional reform if gains are to be had from privatisation and liberalisation.
19. Although a wide range of factors made these economies more vulnerable, the key to preserving macro-economic stability and sustainable growth has been the strength of, and commitment to, market-supporting institutional reform. The crisis has also highlighted the importance for the state to be able to enforce laws, curb corruption, collect taxes, regulate banks and financial markets, implement bankruptcies to promote enterprise restructuring and effective corporate governance, and build the social foundations for a well functioning market economy. These are also the key challenges of the next phase of the transition. They remain at the top of the agenda for the EBRD and, one must hope, for all the countries in the region.
20. The crisis is far from over and many of its effects are not yet discernible. However, while the initial market reaction was severe across the region, a number of the transition economies have demonstrated impressive resilience. Key indicators of domestic and foreign investor confidence (e.g. interest rates and exchange rate shifts) already vary widely across the region, as investors have become more selective in the wake of the broad reassessment of economic fundamentals and risk
21. As a result, the year 1998 has seen substantial variation in the progress of institutional reforms, as measured by the EBRD's 'transition indicators'. Some countries, such as Poland, Estonia, Slovenia and Hungary, have shown further progress in tackling reforms in the financial sector and corporate governance. However, there has also been considerably more 'backtracking' on reforms in 1998 than in previous years. Severe economic problems in a climate of uncertainty have prompted some countries, notably Russia and Ukraine, to revert to direct state controls over economic activity. Other countries (such as Belarus, Turkmenistan and Uzbekistan) have continued to delay essential reforms and even reverse earlier achievements. The reform paths of the transition economies thus differ sharply.
22. The EBRD told the Committee in London that in most cases, 'backtracking' and the postponement of reforms can be traced to the opposition by strong vested interests in the political system - either inherited from communism or forged in the earlier stages of transition. The politics of building the institutions necessary for economic stability and sustainable growth have proved to be extremely complex and fraught with risks to the entire reform process.
23. The risks were demonstrated all too dramatically with the unfolding of the crisis in Russia. There, extreme fiscal pressures in the context of inadequate structural reforms and a highly uncertain political environment produced one of the sharpest setbacks to the reform process in any transition country.
24. However, the Russian crisis and the reform reversals in other transition economies should not overshadow the progress many transition economies have continued to make in 1998. Several countries in which reform was derailed by the pressures of war (Armenia, Azerbaijan, Bosnia and Herzegovina, Georgia and Tajikistan) have begun to make up lost ground, implementing long-delayed plans or adopting new reform programmes.
25. These challenges, however, may carry even greater challenges than those in the first phase of the transition. One reason is that the political and economic dynamics of the reform process have changed. The tasks of the next phase of the transition will include promoting sound corporate governance and enterprise restructuring; deepening and regulating financial markets; strengthening the fiscal system, building an adequate social safety net; and fostering the rule of law. These tasks are of such a magnitude and complexity that it will not be possible to complete them overnight.
26. Moreover, establishing market-supporting institutions while the market itself is functioning and developing at a rapid pace - likened by some to building a ship in the open sea - is an extremely complex process with few historical precedents. As stressed by the Bank's President, there are no simple blueprints for seeing the complex process of transition through. After all, it has never been done before. It is also important to reconcile the principles of a market economy and a pluralist democracy with the cultural and political traditions of the countries concerned.
27. The Bank's Chief Economist, Mr Stern, added that the state must play an important role in meeting these challenges. In this new phase of transition, the state requires more than just the administrative capacity to create institutions. It also has to have the authority to ensure their effectiveness.
28. The capacity of the state varies substantially across the region, but generally speaking serious weaknesses persist in most transition countries. The absence of a well-functioning tax system, especially in the CIS region, places severe fiscal constraints on the state at a time when its need for a minimum of resources is at its most critical point. Even more serious is the low level of state authority in many transition countries. Many governments face extremely low levels of public confidence and trust. This undermines their authority to establish institutions that can effectively alter the behaviour and practices of the population.
29. In this context, the Rapporteur has to stress once more that corruption is both a fundamental cause, and an inevitable consequence of, weak state authority. Corruption distorts state behaviour and, even more importantly, weakens the state's ability to gain consent for, and enforce compliance with, rules and institutions, in that it undermines the public’s trust in these rules and institutions.
30. A further obstacle to progress in meeting the challenges of the next phase of transition is the power structures inherited from the early years of transition. Incomplete or unbalanced economic reforms at the very start of the transition tended to generate flawed markets. These often yielded extremely high benefits for small groups of people, while imposing costs on the rest of society. This combination of a weak state and excessive concentration of market power has in many transition countries resulted in the capture of the state by powerful economic interests, discretionary intervention by state bureaucrats into the market and high levels of corruption.
31. In this environment, the state has been unable to finance itself on a sustainable basis, enforce a proper regulatory framework for the rapidly expanding financial markets, or respond credibly to economic shocks. Nor has it always been able to enforce budget constraints on enterprises, promote good corporate governance or maintain investor and popular confidence in the market.
32. Nonetheless, in most of the countries in central Europe and the Baltic States steady progress has been made in tackling these challenges. Governments of different political orientations have maintained a strong commitment to advancing market reforms. Such commitment draws from a number of inter-related sources, including cultural and historical receptiveness to the market economy, the attraction of the prospect of joining the European Union, broad social consensus in favour of continued reform and vigorous democratic institutions that place constraints on the abuse of state power and the concentration of market power.
33. Paradoxically, breakthroughs in tackling the challenges of any forthcoming phase of transition have often been resulted from fiscal pressures, turmoil in currency markets or banking crises. For instance, a currency crisis in the Czech Republic in 1997 pushed the government to pursue long overdue bank privatisation and reforms, finally severing the bonds between banks, investment funds and large enterprises that had undermined progress on corporate governance reform and enterprise restructuring. In Bulgaria, an extreme macro-economic crisis in early 1997 prompted a new government to undertake long-delayed structural reforms, which have already shown some success in promoting recovery.
34. How governments respond to economic crisis appears to depend on the effectiveness of democratic institutions and the commitment of political leaders. In the final analysis, there is a strong correlation between democratic political regimes and the progress in transition. Here, the Council of Europe makes a valuable contribution in various fields related to democracy, human rights and the rule of law. Indeed, the Committee on Economic Affairs under the Rapporteurship of Mr Elo is currently preparing a report on the "Importance of democracy for Lasting Economic Development", again demonstrating the converging philosophies of the EBRD and the Council of Europe.
35. From the macroeconomic viewpoint, any slowdown in economic growth in western Europe would have significant negative implications for the economies in central and eastern Europe and the Baltic States, even more so than developments in Russia have over the year gone by. For instance, in central Europe, where exports to the European Union account for between and 30% and 40% of GDP, a reduction in imports from western Europe by just 2% could shave around 1% off growth.
36. Trade is an absolute key issue. Countries throughout the region have opened their economies to western trade and are now crucially dependent on such trade to sustain development. It is therefore vital that richer countries - in particular the United States, Japan and the EU - take action to sustain demand and increase efforts to liberalise trade. The Bank's Chief economist, Mr Stern, said it is a fundamental responsibility for the European Union to understand the consequences of its actions vis-à-vis the central European countries. Of particular importance, he said, is the avoidance of any slackening in the speed of accession to the European Union.
37. Indeed, for the 10 applicant countries2 of central and eastern Europe and the Baltics, accession to the European Union forms an integral part of the transition. For one thing, it will require substantial institutional reform. The Rapporteur believes that the prospect of belonging to the European Union can have a positive effect on the candidate countries by making political leaders more responsible and by tempering centrifugal tendencies, not only in respect of foreign policy but also on issues relating to internal democracy and economic reform. For transition to proceed under democratic conditions, stability in the broadest sense is needed. EU enlargement is a major incitement in this regard.
38. On the other hand it will take time at one and the same time to meet the accession requirements, transform enterprises, strengthen financial institutions and build infrastructure. It will also make heavy demands on investment. The accession requirements and adjustment pressures differ from country to country, but in general significant adjustment challenges are expected in heavy industry, mining, food and textiles. The Rapporteur believes that this will also have important implications for the work of the EBRD and other international financial institutions in the coming years.
39. Indeed, in March 1998 a memorandum of understanding was signed between the European Commission, the World Bank and the EBRD with the aim to develop co-financing opportunities, especially in infrastructure and the environment protection. As stressed by Mr Köhler, the Bank will seek even tighter co-operation with other financial institutions to underpin the EU enlargement process. The Bank has also sought closer co-operation with the Council of Europe's Social Development Fund. A new memorandum of understanding on co-operation will be signed at the Bank's annual meeting in London in April 1999.
IV. The impact on the Russian crisis on EBRD activities and the Bank’s response
40. The Committee heard in London that the EBRD in 1998 had faced its toughest test since its foundation. The collapse of financial markets in the Russian Federation, and the repercussions this had throughout the region, posed the perhaps greatest ever challenge to the transition process in the Bank's countries of operation.
41. The collapse of Russia's financial system in August 1998 had a profound effect on the EBRD's operations. The deterioration of the credit quality of investments in Russia and other countries in the region led the Bank to take significant additional provisions by the end of the year, totalling 553 million Euro. Most of the provisions were in the financial sector in Russia. The operating profits before provisions increased to 292 million Euro from 194 million Euro in 1997. However, in 1998 the Bank recorded a net loss after provisions of 261 million Euro.
42. The crisis in Russia has also considerably increased the risk associated with the Bank's projects and operations. Following the turmoil, a higher than expected 40% share of new EBRD commitments in the region in 1998 went to the nine more advanced transition countries, led by Poland, Hungary and the Czech Republic. As a result of the crisis in Russia, the Bank has substantially reduced the scale of its new lending in that country, but it intends to remain engaged in Russian projects.
43. In spite of the difficulties of the region, the Bank continued to make disbursements and to develop projects in all its countries of operations. The Bank now has a portfolio of 550 projects with a total net value of 10.2 billion Euro, making it the largest single foreign direct investor in the region. At the April meeting of the Committee on Economic Affairs and Development, some colleagues expressed reservations as to whether the Bank would be able to pursue its original mandate in all its countries of operations following the events of Russia.
44. At the same time, the Bank is learning lessons from the complexity and cyclical nature of the transition process. It will continue to focus on the development of the private sector, placing a stronger emphasis than before on supporting the local private sector. Against this background, Mr Köhler outlined the following priorities for the Bank as being:
i. to help create sound financial sectors linked to the needs of enterprises and households in providing a broad range of services;
ii. to provide leadership for the development of business start-ups and small and medium sized enterprises;
iii. to promote a full range of commercial approaches to infrastructure development;
iv. to demonstrate effective approaches to restructuring viable enterprises;
v. to take an active approach to equity investment;
vi. to contribute to stronger institutions and an improved investment climate.
45. Mr Köhler said that the Bank in order to fulfil its mandate - implying it will have to take risks and have a critical mass of projects - would strive to reach a lending volume of around 2 billion Euro for 1999. He recognised that this presents a major challenge, as the risks and uncertainties have been growing in the region. As a result, the Bank has to be even more selective and prudent in choosing business partners.
46. As emphasised by Mr Köhler, the Bank is committed to supporting the transition in all countries of operations. However, opportunities will depend on the investment climate in a given country. Thus, the level and nature of the Bank's activities in that country will be strongly influenced by the latter's commitment to reform as well as by its risk profile. By linking projects and technical assistance with an intensified policy dialogue, the EBRD may well be able to bring about improvements in institutions, legislation and the investment climate. A constructive partnership with the authorities includes speaking up clearly against corruption or poor corporate governance.
47. In the Rapporteur’s view, attention should be again drawn to the social strains resulting from the transition and to the deep hardship of the region, particularly in the CIS area. Poverty has risen to truly worrisome levels, comparable only to the period of hyperinflation in the early years of the transition. Dislocation is an inevitable part of the transition, but countries now need strong growth and new opportunities for workers who may have to leave activities that are no longer economically viable; hence the importance of creating favourable conditions for entrepreneurship, in particular in small and medium-sized enterprises.
48. The Rapporteur therefore welcomes the Bank's new approach to engage itself more in the restructuring of large enterprises. This is an area where even the advanced transition countries have many unresolved problems. It is complicated and financially risky, which is why the Bank will focus on few projects with strong 'demonstration effect'. As stressed by EBRD officials, the Bank can contribute in particular by accompanying the restructuring with SME projects, regional venture capital funds and municipal infrastructure projects to give regions new prospects for economic and social development. As regards the strengthening of the SME sector, the Bank has developed a wide range of instruments. It has new projects to promote the development of business start-ups, and it will support banks and financial institutions that have an institutional commitment to long term business relations with SMEs.
49. At the end of 1998 the EBRD had extended loans to banks amounting to nearly 2 billion Euro. Over 80% of these loans are credit lines to be 'on-lent' to small and medium sized enterprises. Through many of its loans to banks the EBRD is able to mobilise funding for local projects that are too small for it to handle directly. This is a crucial part of the Bank's efforts to strengthen private sector development and to stimulate competition in the enterprise sector.
50. The EBRD's largest micro and small loans programme is the Russia Small Business Fund. More that 270 million ECU had been disbursed by the Fund to over 23,000 sub-borrowers by the end of 1998. Not surprisingly therefore, the Fund experienced a difficult 1998, the year of the Russian crisis. Before the financial crisis broke in August 1998, it had consolidated the progress made in previous years with lending volumes increasing steadily along with the range of operations. In the wake of the crisis, however, most of the programme’s key partner banks became financially paralysed.
51. Senior officials of EBRD told the Rapporteur that the Bank is seeking in various ways to preserve the Russia Small Business Fund. Work will continue with less affected smaller and regional banks. On the other hand, the EBRD is considering investing in a newly established Russia Micro-Finance Bank, which is to focus on providing financial services to micro- and small enterprises.
52. Equity investment, if managed properly, can have a powerful transition impact by providing risk capital and promoting sound business practices and corporate governance. Indeed, the Bank's private equity funds are the most significant source of equity financing for SME's in the countries concerned. The funds are a very important means for mobilising additional financing. Their importance in the overall activities of the EBRD is growing. By the end of 1998, the Bank had committed over 670 million Euro to 50 equity funds, making it the largest investor to this segment in its countries of operations. By fostering sound corporate governance and the application of the EBRD's environment guidelines within the ‘investee’ companies, equity funds - with their strong return potential - support the Bank's mandate of ‘additionality’ (supplementing rather than replacing private sector sources of financing).
53. This brings the Rapporteur to the Committee’s discussion on the Bank's investment policy in the energy sector, particularly as concerns nuclear safety3. In reply to references to "dilemmas" and "trade offs" made by Committee members in decrying the Bank's role in this field, Mr Köhler said that in the western half of the continent strong reservations and concerns prevailed against nuclear energy and further investments in that sector. However, western perceptions on nuclear safety were not transferable wholesale to transition economies. The Bank considers the closure of the Chernobyl power station as an overriding environmental concern and will act accordingly. Similarly, the closing down of the Ignalina power station in Lithuania in orderly fashion remains an important Bank priority insofar as its lending policies are concerned.
54. As for the new operational environment of the EBRD, the Rapporteur wishes to draw attention to a special problem. At present, some countries in central- and eastern Europe can obtain funds directly from international capital markets at equally good or even better terms than those offered by the EBRD. This is because of the Bank's long-standing policy of 'uniform pricing', i.e. the practice of applying the same loan conditions to countries with sometimes widely differing risk profiles. This may not have been much of a problem in the early years of the transition, when most transition countries stood at the same level. In the meantime, however, the body of runners has lengthened, with some much farther ahead than others and thus in a better position to obtain better credits from a wide variety of investors. Today, offering credits on uniform conditions tended to 'crowd out' EBRD projects in the more advanced countries of operation.
55. Mr Köhler said that the Bank is re-evaluating the 'uniform pricing' policy, but that any decision would have to be based on a detailed study of the likely consequences. Nevertheless, the Rapporteur believes that the Bank - in order to fulfil its transition mandate in all the transition countries and avoid the previously mentioned 'crowding-out' effect in its more advanced countries of operation - should review its 'uniform pricing' policy, in particular for sovereign loans. Pricing has to reflect risk more closely. There is scope for improving the Bank's risk assessment and provisioning methodology with a view to differentiating country and project risks more clearly.
56. Offering more competitively priced sovereign loans in the advanced transition countries would also allow the Bank to further develop projects in the environment protection and energy efficiency fields - notably together with the European Union in the context of the accession process. Even if the European Investment Bank is considered the natural financing source for infrastructure in central Europe, this should not hinder the EBRD from also having a strong role in long-term financing to this sector.
V. Concluding Remarks
57. 1998 was a crucial year in the Bank’s history. As from the summer of last year the EBRD's region of operation has faced some of its greatest challenges ever since the start of the transition. These challenges have encompassed the financial, social and as well as the political dimensions of change. The financial crisis in Russia and its continuing repercussions in neighbouring countries have had a severe impact on transition. More recently, the crisis in the Balkan region has evoked some of the more pessimistic scenarios the Bank's founding fathers were confronted with at the time of the Bank's establishment: ethnic strife, military operations and a massive exodus of refugees. Although it is too soon to assess precisely what role the EBRD will play in this context, the Rapporteur believes that the Bank should stand ready to provide assistance in the reconstruction in south-eastern Europe once peace has been restored.
58. The turbulent events led to contrasting developments across the region. While some countries were severely affected by the crisis of confidence in emerging markets, others have shown more resilience and have been able to maintain growth, albeit at a slower rate. The Rapporteur believes that this variation confirms an important message in the Bank's Transition Report as well as in previous reports of our Assembly. That message is that hard-won achievements in liberalisation and privatisation must find their counterpart in institutional reform. Only then can macro-economic stability be sustained and the foundations for lasting growth laid.
59. Moreover, the crisis has shown that transition continues to be complex and difficult undertaking, involving as it does the entire society. It will not be completed for quite some time to come. It is now clear, as it was to some observers from the outset, that the transition process is ‘a long haul, not a quick fix’. It has also become clear that the political and economic transition processes are closely intertwined and that political support for reforms is vital for their success.
60. The Rapporteur is also convinced that we must recognise the changing political and economic dynamics of the transition process. The challenges in the next phase of the transition - promoting sound corporate governance and enterprise restructuring, deepening and effectively regulating financial markets, strengthening the fiscal system, building an adequate social safety net and fostering the rule of law - will be at least as taxing as those in transition's first phase.
61. In that new phase, the state will have to do more than 'just' to establish institutions (a difficult task by all means). It must also ensure their effectiveness. Legal systems often still provide too weak a foundation for contracts, investment and financial responsibility. In central and eastern Europe there has been substantial progress in adopting new laws. However, their implementation still leaves much to be desired although the countries applying for EU membership are making significant headway. In the CIS area, however, both the adoption of legislation and its implementation face major hurdles.
62. The complexity and uncertainty of the legal framework make for a situation in which public servants have far too much discretionary power - this being a major factor behind corruption. Successful accomplishment of the transition process will require a continued dogged struggle against bribery, corruption and economic crime. The EBRD and the Council of Europe can and will work together in this endeavour - in what is increasingly considered a top priority for the international community.
63. The Committee's exchange of views with the EBRD's new President showed both the dilemma faced by the Bank in trying to reconcile political directives with market risks, and Mr Köhler's strenuous efforts to extract the Bank from a difficult situation. The Bank's losses in 1998 remind us that it is indeed operating in an in part risky environment. Yet, as several colleagues of the Committee stressed at its April meeting, finding the right balance between risk, return and cost is one of the key challenges the Bank faces as part of its mandate.
64. The Rapporteur fully sees the EBRD's difficulty in reconciling strict investment criteria with its politically inspired statutory provisions. These latter reflect the traditional dilemma of the Bank to strike the right balance between investment banking and development banking. It is therefore more important than ever for the Bank to be circumspect in its choice of partners.
65. The Rapporteur also feels that the Bank's day-to-day activities should better reflect the key challenges for the transition process in the years to come. These are to build an institutional, legal and policy framework capable of serving a well-functioning market economy; to limit fraud and corruption; to promote good corporate governance; to stimulate the development of new enterprises; and to restructure viable enterprises.
66. Company laws incorporating principles of good corporate governance are important for the development of market economies in the EBRD's countries of operations. If foreign and domestic equity capital is to flow to companies in any significant amounts, it is essential that the legislative framework applicable to such companies - as well as charter provisions and contractual agreements among shareholders - reflect principles of good corporate governance. In its capacity as one of the largest investors in many countries in central and eastern Europe, the Baltics and the CIS, the EBRD should seek to assist in the development of such a framework.
67. In the financial area, the Bank should focus on assisting banking sectors that are capable of serving the real economy, including small enterprises. It should also intensify its work to support the growth of small and medium enterprises. The Bank should also seek to support the restructuring of potentially viable enterprises wherever such projects meet the Bank's principles and have a strong 'demonstration effect'. It should work closely with local authorities and seek to combine restructuring activities with projects aimed at SMEs and infrastructure, in order to provide alternative opportunities for those who may lose their jobs. It should also further develop its co-ordination with the World Bank and other international financial institutions (IFIs) to try to cushion the social impact of the restructuring.
68. The Bank should also, through its projects, seek to tackle transition challenges related to cross-border co-operation. The strengthening of intra- and inter-regional infrastructure and trade should be a priority. There is a substantial scope in this area for co-financing opportunities with other IFIs.
69. For the applicant countries of central and eastern Europe and the Baltics, accession to the European Union is already part and parcel of the transition process, and will remain so up to and beyond accession. It will require substantial institutional reform. The EBRD should, through its projects, act more directly to help these countries in preparing for early EU accession, in particular by financing projects to improve their industrial performance, infrastructure and environmental standards.
Reporting committee: Committee on Economic Affairs and Development.
Budgetary implications for the Assembly: none.
Reference to committee: standing mandate.
Draft resolution unanimously adopted by the committee on 27 April 1999.
Members of the committee: Degn (Chairperson), Valleix, Bloetzer, Elo (Vice-Chairmen), Aliko, Andreoli, Attard Montalto, Billing, Blattmann, Bojars, Bonet Casas, Brunhart, Calner, Cunliffe, Cusimano (Alternate: Turini), Durrieu, Eyskens, Frey, Freyberg, Frimannsdottir, Galvao Lucas, Gonzalez Laxe, Grenfell, Gusenbauer, Gylys, Hempelmann, Hoffmann (Alternate: Behrendt), Kacin, Kiratlioglu, Kirilov, Kittis, Kuznetsov, Lazarenko (Alternate: Kosakivsky), Leers, Liapis, Linzer, Lotz, Mateju, Mitterrand, Nagy, Niculescu, Nothomb, Obuljen, Pereira Coelho, Popescu, Popovski, Prokes, Puche, Regenwetter, Rigo (Alternate: Pozza Tasca), Rutskoy (Alternate: Morozov), Schmitz, Shuba, Sorocean, Squarcialupi, Stepova, Stoyanova, Tallo, Tekir, Townend, Vasile (Alternate: Gabrielescu), Verbeek, Verivakis, Wielowieyski, N. … (Alternate: Connor)
N.B. The names of those members present at the meeting are printed in italics.
Secretaries of the committee: MM. Torbiörn, Mezei and Ms Ramanauskaite.
1 Following the terminology of the EBRD Transition Reports, the term “institutions” is used in this report to include: the functioning of the state and the behaviour of its officials, including the issues of corruption and personal safety: the regulatory and legal framework and its effectiveness; the structure and functioning of enterprises, in particular their market orientation; financial institutions; and political and social institutions including the democratic process, the freedom of the press and a social safety net.
2 The applicants from central and eastern Europe and the Baltics are Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic and Slovenia.
3 In its capacity as administrator of the Nuclear Safety Account and the Chernobyl Shelter Fund, the EBRD receives funding from donor governments and the European Union to improve short-term nuclear safety and promote energy sector reforms, transition to a strong regulatory regime and early shut-down of the region's least safe nuclear power plants. The Bank prepares projects, which are submitted, for approval to a decision-making body composed of the donors. In 1998 further progress was made with the shelter implementation plan which aims to assist Ukraine in transforming the sarcophagus around the damaged reactor (Unit 4) of the Chernobyl nuclear power plant into a safer and environmentally stable system.